2/13/2009 @ 7:00PM

The Obama-Geithner Bear Market

Like the Paulson-Bernanke bailouts, the Obama-Geithner policies are plainly chasing an escalating crisis. There’s no place to hide. There’s no way to play catch-up to the rising unemployment, plummeting retail sales, the decline of international trade, and the reality of a still quite sick financial system.

The spectacle of nasty political infighting between Democrats and Republicans in a severe national crisis must be disturbing to investors everywhere. So is the very real question of whether the $787 billion stimulus plan is sufficiently robust or properly focused. The new spending pathetically “repeats the mistakes that got us here,” says Robert Albertson, a principal at Sandler O’Neill and a former
Goldman Sachs
banker.

“After 18 years of record spending, much of it on credit, consumers must and will de-lever and save the next $1 trillion to $2 trillion of income. Only private businesses create job multiplication and true future spending power,” says Albertson. “That requires a savings and investment program, not a doomed spending program. The latter tact ate up the resource base for six years during the 1930s Depression, with little or no effect on unemployment.”

Perhaps that’s why President Obama keeps repeating his favorite one liner: “There is no magic bullet.” Magic and bullets are not what we need. We may just need to borrow from Lincoln and attempt to “disenthrall ourselves,” meaning that we need to think anew about the solutions in 2009.

The plan to save the banks and stabilize the housing market is even more muddled than the misguided stimulus package, and it stirs a lack of confidence in the investor universe. In case you haven’t noticed, Croesus has been regularly intoned that as goes Wall Street, so goes Main Street. The ramifications of a sick financial system contaminate the rest of the economy.

Since the total capital of banks regulated by the Federal Deposit Insurance Corp. is only $1.4 trillion, the banks need another $1.5 trillion of new equity. That’s double TARP 1, and it’s not clear how the vague public-private partnership proposed by Tim Geithner is supposed to come up with that money.

Finding $3.5 trillion for distressed investing is what we’re talking about here. That’s an amount equal to investors’ cash in money market funds, an amount equal to 35% of the nation’s total debt, a large multiple of the capital in sovereign wealth funds. It is not cheap. We’re going to do it because we have to do it.

In May 2008, the write-offs of toxic assets by the banks was only $300 billion. That sounded fantastic. Less than a year later that potential loss of capital has magnified 10 times. In a nutshell, that’s our unbelievable predicament. The masters of the universe were the masters of record losses and destroying their trusting shareholders. No wonder investors have retreated and aren’t following the wishful optimism of the brokers, who can’t earn zip if their customers keep buying Treasury bills.

Market pundits keep trying to inject optimism by comparing the decline in stock prices to other whoppers in 1973 to 1974, 1987 and 2000 to 2002. Since October 2007, the S&P 500 has fallen by 47%–far less than the 86% drop between 1929 and 1932, but frighteningly that matches the 50% drop in the Dow from October 1929 to February 1931. T. Rowe Price Chief Economist Alan Levenson sees “recovery on the horizon.” But what horizon is he imagining?

The failure to adopt radical new policies to jump-start the economy and in one fell swoop to resolve the insolvent bank situation by ridding the overhang of toxic bad paper “increases the risk of a further dramatic equity sell-off,” says Christopher Wood, CLSA emerging markets analyst.

The S&P 500 closed at 833 Friday, meaning the bears see a possibility of a further 25% to 35% drop. Look out below.

The Obama-Geithner team had better do better than the poorly received White House press conference and Geithner’s dysfunctional financial solutions. Haste makes waste, and destructive lack of cooperation from the Republicans in Congress is dispiriting. Obama-Geithner must “disenthrall ourselves” and think out of the box in a radical new way to bring real change.

Croesus predicts incredible Republican opposition to another $1 trillion to subsidize the banks. No tax cuts there; just future potential tax increases. Also, a miserly $50 billion for mortgages to put a floor under home prices seems negligible in the face of a $14 trillion mortgage market.

Smells like overbalance toward the fools and cads on Wall Street than the over-reaching purchasers of homes beyond their means. It’s a quandary that no Treasury secretary could resolve two weeks after taking power.

How is the stock market to take confidence from all this fiddle-faddling? Who has the power to see the future clearly? Not Croesus. It’s a damnable nightmare.